A Bias of Titanic Proportions

Sunday marked the 100th anniversary of the Titanic's sinking. You probably heard about it. Every major news organization covered it. Two cruise ships tossed wreaths into the ocean where the ship sank. A New York food group re-created the final meal of the ship's first-class passengers. "Something about it is intriguing," the group's chef said. It almost felt like an American holiday.

The Titanic's sinking, which claimed 1,500 lives, was a tragedy. But almost no one ever mentions a word about the 1987 sinking of the ferry boat MV Dona Paz, which killed 4,375 people. Or the capsizing of the MV Le Joola, which claimed 1,863 lives off the coast of Gambia in 2002. Using 2010 statistics as a reference, 1,500 Americans likely died in traffic accidents in the last two weeks alone. No food club will re-create their last meal 100 years from now.

Some stories capture our attention more than others that are objectively bigger and more important. I don't know if there's a name for that, but it should have one. Let's call it the Titanic bias.

The Titanic bias shows up in the financial world all the time. We spend too much time focusing on some financial stories while ignoring others that are more important.

Nothing but noiseThink about this: One thousand dollars invested in the S&P 500 in 1950 would be worth about $78,000 today if you focus on the index alone. But with dividends reinvested, your $1,000 actually grew to $622,000 -- eight times higher than the index shows.

Over the long haul, dividends provide the majority of returns. That should be the biggest story investors spend their time and energy on. Yet look what gets almost all the attention in the media: daily market swings of a few points here and there, none of which matter over the long term.

Apple (Nasdaq: AAPL) fell a few percentage points on Monday, bringing shares back to where they were literally a few weeks prior. And the media went wild. By my count, nearly 2,000 articles referenced Apple's "plunge," many as front-page stories.

Meanwhile on Monday, Procter & Gamble (NYSE: PG) raised its dividend for the 56th consecutive year, this time by a lofty 7%. Only a handful of news outlets picked up on the news; most were buried by headlines of Apple's one-day hiccup.

For those looking to build wealth, consistently growing dividends are far more important than daily market wiggles. Yet most of us are captivated by the latter. There's your Titanic bias.

Go where the money isThere's also rampant Titanic bias in the current debate over federal taxes. Most of the tax debate -- certainly the most raucous parts -- focuses on tax rates. We argue over things such as whether to let the Bush tax cuts expire, lower the corporate tax rate, or extend the payroll tax cut.

Those are all important issues. But there's a bigger tax story that often goes unnoticed: how much we spend every year on tax loopholes, deductions, and write-offs such as the mortgage interest deduction and the deductibility of health insurance.

The federal government will take in $2.5 trillion in tax revenue this year. But that's after spending more than $1 trillion on tax deductions and credits (technically called "tax expenditures" since they mimic a cash subsidy), most of which disproportionately benefit those with higher incomes. That's where the money is, folks. Letting the Bush tax cuts expire on those earning more than $250,000 a year would generate $700 billion in tax revenue over the next decade. By comparison, the deductibility of health insurance will likely cost more than $2 trillion during that period. The "Buffett rule" rejected by Congress this week would have raised $47 billion in tax revenue over the next decade. We spend that much on the deductibility of retirement savings every 3.5 months. That should be the big tax story people talk about.

Who's really overpaidThen there's the Titanic bias that exists when we talk about CEO compensation. The media have become fascinated with overpaid CEOs. Former Home Depot (NYSE: HD) CEO Bob Nardelli was obsessively criticized for taking a severance package worth nearly $200 million after the company's stock fell 40% during his tenure. His pay was the topic of dozens of front-page news stories.

Nardelli was grossly overpaid and deserved the criticism. But there are more sinister and widespread examples of corporate overpay that go largely unnoticed. Consider the compensation of money managers.

According to S&P Capital IQ, Nardelli earned $254 million at Home Depot from 2000-2006. That's 0.8% of the $32 billion in profits the company earned under his watch.

Compare that with mutual fund managers. One analysis by Yoseph West of Vuru concluded that management fees collected on equity mutual funds captured one-third of all investor profits from 2000-2010 -- and the vast majority of those funds underperformed a simple index fund. In 2011, U.S. money market funds distributed $5.2 billion in dividends, but only after collecting $4.7 billion in management fees, according to the Investment Company Institute. That's nearly half of all income. And as Reuters explained, many of those funds are run by one (highly paid) manager. Another study by David Norman, former CEO of Credit Suisse Asset Management, found that U.K. investors pay 8 billion pounds a year in hidden fees to financial advisors, capturing upward of one-third of all investor returns. Several years ago I learned that an unsuspecting family friend was being charged 1% a year by a financial advisor to park her money in a product that yielded about 1% a year. The advisor was taking just about everything for himself, in other words. And he called it "work."

Forget Nardelli. Forget the bank CEOs. The real pay scandal is the one Titanic bias shields our attention from, and it's probably affecting you, right now, whether you realize it or not.

It's a terribly complicated world. Whatever you're worried about, frustrated about, or upset about, there's probably a bigger issue out there that deserves your attention. Something about that is intriguing, you might say.

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It's a complicated subject, but there are strong arguments against even the health insurance subsidy: It just pushes up health insurance prices, which makes it particularly difficult and unfair for those buying it on their own (and not through their employer).

"Those are all important issues. But there's a bigger tax story that often goes unnoticed: how much we spend every year on tax loopholes, deductions, and write-offs such as the mortgage interest deduction and the deductibility of health insurance."

These "so-called" tax loopholes were created by legislators. They are perfectly legal. They allow you to keep more of your hard-earned money. They prevent the government from taking more than they should (but not nearly enough).

We need more "loopholes" not less. I believe all taxes are unethical and immoral, but if you like paying taxes be my guest. Perhaps you prefer the Buffet rule, where he thinks all wealthy people should pay a lot more in taxes, while he minimizes his, but taking advantage of those same loopholes. He takes a relatively small salary, and donates huge portions of his wealth to foreign countries as part of the Bill Gates plan.

It is his money and he spends it the way he wants. I don't have a problem with that, as a matter of fact that is what I wish to do.

Having never been seduced by the Titanic mega melodrama, your opening really caught my eye, Morgan. Though the Foolish discussion has focused on taxes, loopholes, etc, the bigger picture is that we need to see the bigger picture. It's taken me more than a year to not get caught up in the daily roller coaster rides the market offers. The political arena, and especially political campaigns, are expert at distracting voters from real issues. There are some outrageous inequities in the market and elsewhere, as you point out, but most didn't come into being and manage to stay in existence without complacence, ignorance, or tacit assent of others.

seduced is missing the point entirely. Well mostly, since journalists, newspapers, and writers are basically whores selling their wares and always have been so. yet recent news has shown us how our banks are run by manipulative scoundrels and we wonder why the bank allows this?

Guess what!

It's the "good ole budy" deal!! And our government, if you want to be so generous as to call them governing, is the same.

You sound very anti-government yet you are for lots of tax loopholes? Higher tax rates and higher levels of loopholes gives the government more power, not less. They get to pick winners and losers and of course the lobbyists play their game to get their share or more. If you lower rates and take away all deductions, it would be fair for everyone and the special interests would go away. Simplifying the tax code will not end all of America's fiscal problems but it would be a great start.

Agreed. I'm absolutely for all tax deductions and credits to be removed (perhaps leave in the child credit) and the tax rates to be pushed down. This will reduce manupulation and distortion of the free market. And probably lower my tax bill.

Certain loopholes are probably pretty worthwhile as a society - making basic foods tax-exempt, for example.

I would also like to note that your taxes could be greatly simplified by simply making filing a tax return optional. The IRS is already going to calculate your tax bill anyway. It would be extremely simple to just let them send out a tax bill, and then you could check it with the forms if you wanted. The vast majority of people would not bother, and the people who would want to check it are most likely the people who can afford to employ accountants anyway.

Instant savings in time, money, and frustration.

Unfortunately this extremely simple and easy fix is opposed by, naturally, tax prep companies, and of course anti-tax Republicans like Grover Norquist, who have consistently opposed proposals to make tax filing easier.

I should note that the Motley Fool covered this issue in 2005 and found that when California implemented such an option, essentially everybody not named Grover Norquist was thrilled with the results:

"In 2011, U.S. money market funds distributed $5.2 billion in dividends, but only after collecting $4.7 billion in management fees, according to the Investment Company Institute. That's nearly half of all income."

You would think an investment writer would be able to understand the difference between dividends and income.

Was I wrong to do this? Did I burden your poor little fragile American economy with my immoral desire to keep the fruits of my labor?

ROFL

Yes, dividends are great. The rest of this is anticapitalist garbage that would make Ellsworth Toohey proud. It's amazing how many anticapitalist writers are at TMF.. Oh, I know. They claim to be moderates... But the moderate view in America is very anticapitalist.

Don't feed the State. It just kills brown people. Get as many tax breaks as you can.

Realistically speaking, a state that funded it's self solely through donations of some form or another would be the most ethical proper way of raising revenue.

But very few states have ever been known to do the ethical or right thing. Pragmatically speaking, a low flat tax would be more ethical, but it's been shot down a million times over and progressives scream about how it's unfair for everyone to pay the exact same tax rate...somehow....

So I don't begrudge anyone for taking every deduction they're allowed, and some they aren't.

"Realistically speaking, a state that funded it's self solely through donations of some form or another would be the most ethical proper way of raising revenue. "

Purely as thought experiment, how big a state do you think that could maintain, in terms of population and economic activity (and, for that matter, geographic territory)?

I suspect the biggest limitation would be finding the point at which cultural homogeneity begins to disintigrate. Places like Norway and Sweden are highly socialist and everybody seems to agree that that's what they want. It's not exactly donations but it's as close an approximation as we have on the nation-state level. And they aren't very big, in any of those respects, at least relative to the United States.

Do you think the US as presently incorporated could survive under such a system? I would suspect it would require some fairly radical change and some major reapportionment of population, but I could be wrong.

Very interesting.

I will note that in a representative government with freedom of movement, you are under no obligation to continue to bind yourself to a particular nation's tax regime and (ostensibly) have the option to modify that tax code if one can generate sufficient support, which gives taxes in such a situation every bit as much moral weight as voluntary donations.

However, before you protest, I recognize that we lack a unified global government and individual nations are loath to allow unrestricted movement despite ostensible claims of participating in a free society, and that our representative government has a hard time being properly representative in such a large and diverse nation and with such an influx of monetary influence in the political sector, so those options are circumscribed to some extent.

David - the $92,000 foreign income exclusion is predicated on paying the income tax of the foreign nation in question, is it not? So it's not protecting you from paying taxes so much as transferring them to your actual location.

That's my understanding, anyway, but I'm really unsure about that and would appreciate some additional clarity. I move to Canada next week so it's becoming particularly relevant. :lol:

I generally agree with the principle that any reduction in taxation and thus reduction in the size of the state is good.

However, I agree with Morgan and others at TMF that the health insurance deduction as well as the mortgage interest deduction should go.

The size of these deductions is on one hand an example of how much extra money the government could raise by eliminating them. On the other hand, it is a great illustration of how manipulative and damaging to the free market those incentives are. Student loan interest is another example.

Let's see. We are recovering from a massive crisis caused by many things, but I would argue that the one thing that this crisis couldn't have done without was artificially inflated housing prices. The two most popular projections for the roots of the next crisis to hit our economy are health care costs and student loan debt.

The three most dangerous developments in our economy are directly tied to three of the largest tax deductions. I don't believe this is a coincidence.

Yes we know the loopholes are legal. That is why they are called loopholes. If you think taxes are evil you must admit they are a necessary evil. Without them the government wouldn't be able to keep up with our infrastructure. I don't like paying them as much as the next person and I am unhappy with how my taxes are allocated but I do realize the necessity. Also if you prefer to donate your money to a good cause, you won't be taxed on it. So don't get so upset!

Surely everyone wants minimum tax rates. That is the only practical ethical thing possible. The right and left extremes as canvassed above just do not stand logical consideration.

One of the main barriers to low rates is the existence of tax deductions for favoured groups. Of course it may be your right to claim these deductions but everyone else gets to pay for your privilege. How is that ethical?

It is much preferable to eliminate all tax deductions and for Governments to subsidise those activities it favours. We still get to pay for other people's choices but everyone gets to pay including those who benefit.

people chose relative to a fixed frame of reference P&G is a really big company so it doesn't really make headlines. The Titanic in its time was the largest passenger ship ever built. People tend to think in relative terms not absolute ones which as seen can produce massive losses over time.

no loopholes... a flat tax... if you make more money... you have more income to be taxed... I'll even go so far as to exempt all income that is below the poverty line... so if the GAO says the poverty line for a family of four is 22K, then then the first 22K is expempt... you pay taxes all year, and if you make less than that, you get all you paid back... if you make 44K, then you're only going to pay taxes on half your income... Bill Gates will have his first few minutes of his first day of work tax free... no forms to file, no deducitons... who cares if Joe bought a house, or Sally has 8 children (though her poverty line will be higher). I paid 5% in taxes last year, and less than 1% the year before. That's nuts... how is that fair? Am I crazy for advocating that my taxes go up... maybe... but we are bankrupting the country... both sides, republicans and democrats... for crying out loud... it's time to buckle down and pay the bills... Increase revenues and decrease expenditures... why is it so hard...just my two cents... sorry for the rant... Chris

<<Purely as thought experiment, how big a state do you think that could maintain, in terms of population and economic activity (and, for that matter, geographic territory)?>>

A small one, and that's the point. The original articles of confederation, which were essentially volunteer based funding for the Federal government, were floating at around 1-2% of GDP per year (as opposed to the 30+% of GDP the federal government currently exists at). This was around the same historical average of federal spending post confederation, pre income-tax as well. A 1-3% government is perfectly adequate to do all government type things, and it's perfectly feasible under a completely voluntary system.

Of course that would change the current scope of the government. But I don't think the population or geographical area would be a factor. The determining factor would solely be in the mindset of the citizens. Once people accept that the citizens and the states are responsible for themselves, that the federal government should own no land, and that wars of aggression are never tolerable, we can get back to a 1% federal government. Until then...not a chance.

I concluded some time ago that people really hate numbers but prefer "semantics" and "position statements." In particular if the statements support one's position. Numbers frequently don't do that. Of course, we can also pick and choose our data points so as to support our position, and that has become the method of choice.

We argue about who is rich and who is poor, but what does that really mean? If one works 40 hours a week and can't earn a living wage, is that "poor" or, if one sits at home on the dole and can't make ends meet is that "poor?" The census bureau has some interesting statistics about the "poor" and the amenities they enjoy.

I was shocked (again) by the comments about the shooting death of someone called "Trayvor." and that includes those made by the President. Meanwhile in Chicago, in that same week, it was reported that 50+ people were killed in crime related incidents, and that included a 6 year old sitting on a porch, who was gunned down.

I concluded years ago that what is reported or is emphasized is a function of gaining political advantage.

As for the Titanic, I am also of the opinion that it was also as significant an event as the Space Shuttle Columbia blowing up. The powers that be spoke of the "pinnacle" and yet the Titanic was sunk! Most people don't seem to realize that the Titanic was the absolute peak of 19th century engineering (I know, it sailed in 1912) and it was the culmination of the knowledge of the "steam age."

For the U.S. the "space shuttle" was the pinnacle of the 20th century space age.

As with the shuttle, the Titanic took the so called "best" to the bottom.

When the politicians were running for the presidency in 2008, there was a lot of "crap" debating about the rich. At the time, I was appalled. It's easy to determine who is "rich" and one could summarily say it's anyone above the average income. Then let's look at assets. Again, it's easy.

But the pols prefer to obfuscate and divert attention. It's no accident most politicians at a national level are lawyers. I also suspect most would flunk a basic economics class.

Frankly, listening to these people is about as entertaining as watching "my night in paris!"

Disclaimer: never saw the "movie" but I'm glad she was cut off from the Hilton inheritance. Who says their is no justice? There, is, but is seems to occur all so infrequently!

Another good, thought-provoking (and comment producing) article. I agree with most of your thesis, with the exception of categorizing the various deductions and exemptions as subsidies and "costs" to the government.

With the possible exception of "refundable tax credits", which are paid even to those who have no tax liability (essentially a welfare check), tax deductions are most definitely NOT "costs". Nowhere in the federal budget is there a line item labeled "Tax Deductions, Refunds, Exemptions, & Write-Offs" or "Bush's Tax Cuts". You said the government brings in appx $2.5T in revenue. That's where the statement should end. The question from there is: "Why can't our government operate efficiently on that amount?"

Refunds and deductions, up to the amount of tax liability aren't "subsidies". It's only a subsidy insofar as it's in excess of taxes paid. At that point it becomes true cost to government, not until.

It's a subsidy because it encourages a specific behavior-- picking winners and losers. If I rent and you own (and pay interest), your taxes will be lower than mine, all else equal. It would be no different whatsoever if the govt wrote you a check as a subsidy to pay your mortgage, financed by me, the renter.

Imagine all deductions went away, and there's a flat tax Now imagine the government announced it would write homeowners a check for one third of their mortgage interest (or whatever the proportion of their tax rate is) every year. What would the difference be? None. That's why they call these tax expenditures.

The fact that there is no line item on the budget for deductions is exactly what makes them dangerous: the true costs are hidden.

That's all I can do, imagine it. With the current politcal classes it will never be more than a dream of Libertarians.

I'll grant you the example of Mortgage Interest deduction, but politicians label Income Tax refunds and lowered rates as "costs" as well. I can't understand the mindset that describes allowing Americans to keep a greater percentage of the rewards of their labor is somehow taking money out of the pocket of government.

"David - the $92,000 foreign income exclusion is predicated on paying the income tax of the foreign nation in question, is it not? So it's not protecting you from paying taxes so much as transferring them to your actual location."

Not necessarily. I work overseas and do not pay any taxes to a foreign government bu (I work in Germany under TESA rules) t still qualify for the foreign earned income exclusion up to the allowable limit. (~$92K)